BENJAMIN BUPAMBA from Tanzania message
Toyota Motor Corporation is one of the largest automakers in the world. At its annual conference in Tokyo on May 8, 2008, the company announced that activities through March 2008 generated a sales figure of $252.7 billion, a new record for the company. However, the company is lowering expectations for the coming year due to a stronger yen, a slowing American economy, and the rising cost of raw materials (Rowley, 2008). If Toyota is to continue increasing its revenue, it must examine its business practice and determine on a course of action to maximize its profit.
One method that Toyota can consider is using the price elasticity of demand to determine whether to increase or decrease the sale price of their automobiles. The responsiveness or sensitivity of consumers to a price change is measured by a product’s price elasticity of demand (McConnell & Brue, 2004). Market goods can be described as elastic or inelastic goods as change in quantity demanded for that good. If demand is elastic, a decrease in price will increase total revenue. Even though a lower price would generate lower sales revenue per unit, more than enough additional units would be sold to offset lower price (McConnell & Brue, 2004). In a normal market condition, a price increase leads to a decreased demand, and a price decrease leads to increased demand. However, a change in income affecting demand is more complex.
Types of goods will help us determine whether demand for cars is elastic or inelastic. If a good is considered to be a luxury rather than a necessity, the greater is the price elasticity of demand (McConnell & Brue, 2004). Cars can be deemed as necessary due to a need for transportation. Other types of cars can be classified as luxury. A person who needs to be able to get from one place to another will have the need for a car. An old vehicle may suffice. In such a scenario, buying a brand new car is more likely to be a luxury rather than a necessity. If car prices go up, people are more inclined to just keep driving their old vehicles. In essence, the cars already on the road would serve as substitutes for new cars. However, over a longer period of time, old cars tend to wear out and the elasticity of demand for vehicles is less.
Toyota is known for its lineup of high gas mileage and low maintenance vehicles. Gasoline and cars are complementary goods for each other. As gas prices increase, demand for Toyota vehicles will also increase because the automaker produces a wide range of fuel-efficient vehicles. The most important influence on the elasticity of demand is the availability of substitutes for the product. As substitutes are more readily available, the elasticity is greater. In a purely competitive market, where there are many perfect substitutes for any one product, the demand curve for that one product is perfectly elastic (McConnell & Brue, 2004). Toyota, Honda, and Nissan are three of the biggest Japanese automakers and all three have a reputation for high gas mileage vehicles. Honda and Nissan are excellent substitutes for Toyota. If the price of a Toyota vehicle increases, the demand for that vehicle will decrease because many substitutes are available.
If the income of Toyota customers were to increase by 10%, it would be expected that the demand would increase by about 10% as well. This rational is based on the concept that “the higher the price of a good relative to consumers’ incomes, the greater the price elasticity of demand” (McConnell & Brue, 2004).
The reason behind the increase is the concept of income elasticity of demand, which “measures the degree to which consumers respond to a change in their incomes by buying more or less of a particular good” (McConnell & Brue, 2004). Toyota vehicles would be considered superior goods, which are highly elastic. For example, in difficult economic times, automobiles and other superior goods are some of the first items to get cut because consumers simply cannot afford them. However, when times are good and incomes increase, superior goods jump significantly compared to products that have low or negative elasticity.
In today’s economy, Toyota has fared decently depending on the segment of automobiles analyzed. According to Jean Halliday (2008), the sales of new cars plummeted 12% in March 2008 due to the high number of foreclosures and increased gasoline prices. This figure is for the entire industry except for the ‘B-segment,’ which “consists of compact budget brands” (Halliday, 2008). Included in this segment is the Toyota Yaris, which “was the top seller among the B team last month, reporting sales of 12,953 units, 83% higher than March 2007” (Halliday, 2008). “Demand has just skyrocketed,” said Tom Libby, senior director of auto consultant at Power Information Network, about the Yaris. Factors contributing to the increased demand can be “cheaper sticker prices, better fuel economy and more fun-to-drive models” (Halliday, 2008).
“March was the third-consecutive month that small-car sales were up in a down market” (Healey & Woodyard, 2008). The Yaris was a standout in March, which was up 70%. “Yaris … I’ve never seen a model in that segment with sales that high, ever,” said Libby (Healey & Woodyard, 2008). These figures indicate that while the current economy is slumping, sales of the gas-friendly, cheaper models are keeping Toyota auto sales afloat and minimizing the impact of decreasing sales of the larger, more expensive models. The authors believe that if consumers’ incomes were to increase by 10% and given the current economy, the sales of the compact, cheaper and gas-friendly models would continue to increase more than the luxury and gas-guzzling models.
By examining the price and income elasticity of demand, Toyota can develop a sales plan that will carry the company through the current economic downturn. An emphasis in production, marketing, and sales of the Toyota Yaris would enable the company to take advantage of the rare opportunity afforded to them based on consumer demand. As one of the largest automakers in the world, Toyota must constantly adjust to changing conditions within its operating environment in order to maintain and strengthen the grip it has on the auto market.